Chapter 7, Problem 18P

Henderson Office Supply is considering a more liberal credit policy to increase sales, but expects that 9 percent of the new accounts will be uncollectible. Collection costs are 6 percent of new sales, production and selling costs are 74 percent, and accounts receivable turnover is four times. Assume income taxes of 20 percent and an increase in sales of $\text{\$65,000}$ . No other asset buildup will be required to service the new accounts.

a. What is the level of accounts receivable to support this sales expansion?

b. What would be Henderson’s incremental aftertax return on investment?

c. Should Henderson liberalize credit if a 16 percent aftertax return on investment is required?

Assume that Henderson also needs to increase its level of inventory to support new sales and that inventory turnover is two times.

d. What would be the total incremental investment in accounts receivable and inventory to support a $\text{\$65,000}$ increase in sales?

e. Given the income determined in part b and the investment determined in part d, should Henderson extend more liberal credit terms?